I N V E S T O R S
October 16, 2014
M. E. Miller Investors (MEMI) Update for the Third Quarter of 2014
By some measures the third quarter was uneventful, with another small gain for the S&P 500, which is
dominated by large domestic companies. However, beneath the surface the story becomes a bit
murkier. The Russell 2000, the benchmark for small US stocks, declined more than 7%. As the quarter
wore on, the markets deteriorated from within as more and more investors sought out a narrower and
narrower group of the largest companies. As money flowed to these mega-cap stocks, a glance at the
Dow Jones or S&P 500 reflected a deceptively rosy picture of the markets. Usually these divergences
do not resolve themselves peacefully or pleasantly. So far in the early part of October volatility has
increased, all equity markets have declined, and the fear assets – gold and treasurys – have been in
favor.
Are the markets finally reacting to unrest overseas, from Syria to Ukraine to Hong Kong? Or perhaps
they are now truly concerned that China’s breakneck economic growth is slowing. Or maybe equities
have just reached valuations in this post financial crisis bull market at which investors are more
discriminating with new purchases. The answer is likely all of the above and more. While I know
volatile markets are unpleasant for most investors, I like nothing better. My assessment of the value of
our companies is based on many years of future cash flows, and those have not changed. Volatile
markets just provide me the chance to buy more shares of those companies for you at lower prices.
In conjunction with the following returns data, please read the important disclosures at the end of this letter.
(through 09/30/2014)
3Q
2014
YTD
2014
Trailing
5 Years
Since
Inception
CAGR*
Since Inception
(01/01/2008)
(01/01/2008)
MEMI (net of fees)
-1.12%
13.44%
115.83%
96.73%
10.09%
S&P 500
1.13%
8.34%
107.30%
55.76%
6.78%
Difference
-2.25%
5.10%
8.53%
40.97%
3.31%
Total Returns
*Compound Annual Growth Rate
About M. E. Miller Investors (MEMI)
I founded MEMI in 2007 to manage an equity portfolio of 10-20 long-term holdings. My mission
is to provide superior long-term, after-tax equity returns to patient investors. I seek to invest in
companies with large growth opportunities and particularly resilient business models that allow
those companies to earn outsized returns on capital for many years. I am a traditional investor – I
do not short stocks, use options or other derivatives, or charge performance fees. I believe that a
long time horizon, good judgment, and an even temperament are the keys to successful investing.
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I N V E S T O R S
Performance Attribution and Portfolio Management
While I am hopeful that recent volatility will provide buying opportunities in 4Q, the third quarter was
unusually slow from a trading perspective. Few changes were made in your portfolio, with no new
companies added, and none completely liquidated. No market is more frustrating for a portfolio manager
than the slow rise with low volatility. Each morning I am excited for the market to open to see if I will
have the chance to scoop up a bargain, and during these times, each morning I am disappointed.
While that summary makes it sound as though I spent the third quarter watching the market open and
then sunning myself on the beach the rest of the day, in reality boring markets are a great time to restock the pipeline with future opportunities. During these periods, I research new companies, establish
my estimates of their value, and then decide how great a discount to that value I demand to invest your
money in them. That provides me a list of great companies I would like to own, and target prices at
which I would be willing to invest. If volatility continues to pick up and stocks decline, you will end up
owning some of these new companies, reaping the rewards of seeds sown in the dull times.
As I await those opportunities I am maintaining a higher allocation to cash than at most times in the past.
Currently about 10% of your assets sit in cash, awaiting worthy investments. This is close to the
maximum with which I am comfortable. That gives me plenty of flexibility to buy stocks quickly if
prices decline, while not keeping so much of your assets un-invested as to risk missing a bull market run.
I believe the greatest risk for the long term investor is being under-invested during the massive bull
markets that have historically come about every 30-40 years. Those bull runs in the past have
compounded by 10-15 times over 15-20 years. If your time horizon is long enough, even the worst
drawdowns are dwarfed by the subsequent returns. I would much rather be buying stocks all the way
down than be sitting in cash all the way back up. Participating in just one of those giant bull markets
creates life-changing wealth for many investors.
Now on to the stars of the show – your portfolio companies. During the third quarter only one of your
companies had a marked rise in stock price. Fortunately it was Under Armour, one of your larger
holdings. The stock gained 16% during the period after posting another fantastic quarter of sales and
earnings, highlighted by accelerating growth in shoes and in sales outside the US. The company had
previously stated goals to focus on both of those initiatives, and so far is outperforming expectations. I
believe it is still early days for Under Armour. The company has established itself as the only serious
challenger to Nike and Adidas, but is still tiny in comparison, with less than 10% of Nike’s revenue.
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I N V E S T O R S
Three stocks in the portfolio declined more than 10%. All are small positions because all are small
companies with riskier prospects than many of your holdings. None of the three companies experienced
any important developments to which the stock price moves can be attributed. They were simply
examples of small companies whose stocks declined as investors sought out less volatile, less risky
investments. Each of them is involved in cutting edge medical research.
Fluidigm, the most recent addition to the portfolio, declined 17%, allowing me to increase your stake
at bargain prices. The company makes life science research equipment, much of which enables
scientists to examine single cells to better understand the workings of the human body. Fluidigm is still
managing through the troubles it inherited when it bought another company with a complementary
single cell technology. That ill-advised deal earlier this year gave us our original opportunity to pick up
shares at attractive levels. Until the company can show investors that it has fixed the problems in the
acquired business without losing focus on the core business, the stock is likely to remain in the bargain
bin. When companies are successful in navigating this sort of turnaround, their stock prices usually revalue swiftly and suddenly as soon as positive developments come to light. The rewards of that revaluation accrue to investors lucky enough to buy just ahead of the stock price move and those patient
enough to wait for it. I have much more control over patience than luck, so for now I am happy to wait.
Kythera, the biotech company with its first drug awaiting FDA approval next spring, dropped 15%
during the period. I met with the management team again in July and remain confident in the drug’s
safety and efficacy profile, and in the company’s ability to create substantial value for shareholders
over the long term. The company was built by executives who cut their teeth at Amgen and Allergan,
two heavyweights in the industry. By all appearances they are highly capable, and are intent on creating
the next major aesthetics-focused company.
Finally, Immunogen, the biotech company with a novel approach to making more potent cancer drugs,
declined 11% during the quarter and more since. I have added to our stake in small pieces as the stock
declined without any news or fundamental changes of which I am aware. At current prices I believe the
value of the royalty stream from the company’s approved drug is more than equal to the stock price.
Thus, we are getting the rest of Immunogen’s assets for free, including the company’s internal pipeline
and potential milestone and royalty payments from licenses granted to other companies. The list of
companies that have taken licenses to develop drugs using Immunogen’s technology is a who’s who of
major pharma and biotech, including Novartis, Amgen, Eli Lilly, Roche and Sanofi. Given the quality
of the research organizations at those companies and the proven success of Immunogen’s technology, I
expect at least some of those collaborations to bear fruit one day.
Please review the important disclosures on the next page.
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I N V E S T O R S
Important Disclosures - Please Read
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M E Miller Investors (MEMI) is a registered investment advisor, managing a concentrated long-only allcap equity portfolio for individual clients.
The U.S. dollar is the currency used to express performance.
The results shown represent the performance of one account, managed to mimic the firm's model
portfolio, but is not necessarily identical to the firm's other managed accounts. The portfolio manager
may have had clients that experienced investment performance that was materially different than the
results shown above.
Results are shown net of all transaction costs and custody fees and net of an estimate of MEMI’s fees.
However, as the account shown is not a full-fee paying account, the drag that deducting MEMI’s fees
from the account on a quarterly basis would cause is not fully represented. Account records for full-fee
paying clients are available to persons seeking to quantify that drag effect.
MEMI's fees for discretionary accounts are 1% of assets up to $5M, and 0.80% of assets above $5M.
Fees are collected quarterly in arrears, which produces a compounding effect on the total rate of return net
of management fees. More detail on MEMI's fees, as well as custody and transaction fees is available in
MEMI's form ADV and related schedules.
The investment results shown include the reinvestment of all dividends and interest earned by the
managed portfolio during the period reported.
Performance shown represents the value-weighted rate of return, calculated as (ending value/starting
value) -1.
The investment results shown reflect past performance and should not be considered an indication of
future investment performance. Risk is inherent in this type of investment, and future performance may
involve the possibility of loss.
Results shown above do not represent a composite of MEMI managed accounts, nor are they GIPS
compliant. Results from other managed accounts are available on request.
The benchmark used for comparison is the S&P 500 (with dividends).
Results for the MEMI portfolio are shown on a cash basis, while results for the benchmark are on an
accrual basis. Records for all periods are available to persons wishing to reconcile the cash to accrual
returns.
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310.459.2560
www.meminvestors.com